ECON 202 1st EditionExam # 1 Study Guide Chapter: 1 – 4Chapter 1 Individual Choice: The 12 Principles1. Choices are necessary because resources are scarce.Resource: anything that can be used to produce something else.Scarce: in short supply; a resource is scarce when there is not enough of the resource available to satisfy all the various ways a society wants to use it.2. The true cost of something is its opportunity cost.Opportunity cost: What you must give up in order to get something.3. “How much” is a decision at the margin.1. Trade-off: Comparison of the costs and the benefits of doing something. a. Example: eating a candy bar (cost and benefit)Marginal decision: decision made at the margin of an activity about whether to do a bit more or a bit less of that activity.Marginal analysis: the study of marginal decisions.Ex: taxing or banning soda because of its negative health 4. People usually respond to incentives, exploiting opportunities to make themselves better off.Interaction and Individual Choice Specialization:5. There are gains from tradeTrade allows us all to consume more than we otherwise could.Specialization: the situation in which each person specializes in the task that he or she is good at performing.6. Markets move toward equilibrium.Equilibrium: An economic situation in which no individual would be better off doing something different.7. Resources should be used efficiently to achieve society’s goals.Efficient: taking all opportunities to make some people better off without making other people worse off.Equity: a condition in which everyone gets his or her “fair share.” (There are many definitions of equity.)Equity and efficiency are often at odds.8. Markets usually lead to efficiency.People normally take opportunities for mutual gain9. When markets don’t achieve efficiency,government intervention can improve society’s welfare.Sometimes markets fail and need correction.Economy-Wide Interactions10. One person’s spending is another person’s income.**During recessions, a drop in business spending leads to:Less income, less spending……and further drops in business spending, layoffs, and rising unemployment.11. Overall spending sometimes gets out of line with the economy’s productive capacity.12. Government policies can change spending.Chapter 2Supply and Demand and PPF- A competitive market has many buyers and sellers of the same good or service, none of whom can influence the price.- The supply and demand model is a model of how a competitive market behaves.- Demand represents the behavior of buyers.o A demand curve shows the quantityo Demanded at various prices.o The quantity demanded: the quantity that buyers are willing (and able) to purchase at a particular price.***a “change in demand” does NOT equal a “change in quantity demanded”The Law of demand: a higher price for a good or service leads people to demand a smaller quantity.Understanding Shifts of the Demand CurveImportant demand shifters:1. Changes in the prices of related goods or services2. Changes in income3. Changes in tastes4. Changes in expectations5. Changes in the number of consumersChanges in Price of Related Goods: Substitutes- Two goods are substitutes if a decrease in the price of one leads to a decrease in demand for the other (or vice versa).- What happens to the demand for travel in Hawaii if the (perceived) safety cost of traveling to Mexico increases?Changes in Price of Related Goods: Complements- Two goods are complements if a decrease in the price of one good leads to an increase in the demand for the other (or vice versa).- Consumers often have to buy goods together.- An increase in price of gasoline will decrease the demand for SUVs.Changes in Income- The effect of changes in income on demand depends on the nature of the good in question.o A normal good: Demand increases when income increases (and vice versa).o An inferior good: Demand decreases when income increases (and vice versa).Change in taste- Taste in preferences are subjective and vary among consumers-Seasonal changes or fads have a predictable effects on demand.- What happens to demand for boots in October?Change in expectation- If consumers have a choice about the timing of a purchase, they buy according to expectations.-Buyers adjust current spending in anticipation of the direction of future prices in order toobtain the lowest possible price.o If prices for Xbox 360 consoles are expected to drop right before Christmas, what will happen to sales during November?Change in number of customers- As the population of an economy changes, the number of buyers of a particular good also changes (thereby changing its demand).o What happens to the demand for diapers in Russia as birth rates drop?SupplySupply represents the behavior of sellers.A supply curve shows the quantity supplied at various prices.The quantity supplied is the quantity that producers are willing and able to sell at a particular price.Understanding Shifts of the Supply CurveImportant supply shifters include changes in:1. input prices.2. the prices of related goods or services.3. technology.4. expectations.5. the number of producers.Chapter 3Interference in markets has consequencesI. Price controlsa. Price controls: legal restrictions on how high or low a market price may go. There are two main types:b. Price ceiling: a maximum price sellers are allowed to charge for a good or service (usually set BELOW equilibrium).c. Price floor: a minimum price buyers are required to pay for a good or service (usually set ABOVE equilibrium).II. How Price Ceilings Cause Inefficiency a. Price ceilings cause predictable side effects:i. Inefficiently low quantityii. Inefficient allocation to customersiii. Wasted resourcesiv. Inefficiently low qualityv. Black marketsIII. Inefficiently Low Quantitya. When prices are held below the market price, shortages are created.b. The lower the controlled price relative to the market equilibrium price, the larger the shortage.IV. Inefficient Allocation to Customersa. Price controls distort signals that would help the goods get allocated their highest-valueduses. b. Consumers who value a good most don’t necessarily get it. So producers have no incentive to supply the good to the “right” people first.i. As a result, goods are misallocated.V. Wasted Resourcesa. Price controls that create shortages lead to bribery and wasteful lines.b. Shortages: not all buyers will be able to purchase the good.c.